Four Fallacies Of The Second Great Depression
Robert Skidelsky
The
period since 2008 has produced a plentiful crop of recycled economic
fallacies, mostly falling from the lips of political leaders. Here are
my four favorites.
The Swabian Housewife. (in NZ read "Waitakere Man" )“One
should simply have asked the Swabian housewife,” said German Chancellor
Angela Merkel after the collapse of Lehman Brothers in 2008. “She would
have told us that you cannot live beyond your means.”
This
sensible-sounding logic currently underpins austerity. The problem is
that it ignores the effect of the housewife’s thrift on total demand. If
all households curbed their expenditures, total consumption would fall,
and so, too, would demand for labor. If the housewife’s husband loses
his job, the household will be worse off than before.
The
general case of this fallacy is the “fallacy of composition”: what
makes sense for each household or company individually does not
necessarily add up to the good of the whole. The particular case that
John Maynard Keynes identified was the “paradox of thrift”: if everyone
tries to save more in bad times, aggregate demand will fall, lowering total savings, because of the decrease in consumption and economic growth.
If
the government tries to cut its deficit, households and firms will have
to tighten their purse strings, resulting in less total spending. As a
result, however much the government cuts its spending, its deficit will
barely shrink. And if all countries pursue austerity simultaneously,
lower demand for each country’s goods will lead to lower domestic and
foreign consumption, leaving all worse off.
The government cannot spend money it does not have. This
fallacy – often repeated by British Prime Minister David Cameron –
treats governments as if they faced the same budget constraints as
households or companies. (in NZ this is the favourite mantra of both Key (the gambler) and English (the "finance" minister) But governments are not like households or
companies. They can always get the money they need by issuing bonds.
But
won’t an increasingly indebted government have to pay ever-higher
interest rates, so that debt-service costs eventually consume its entire
revenue? The answer is no: the central bank can print enough extra
money to hold down the cost of government debt. This is what so-called
quantitative easing does. With near-zero interest rates, most Western
governments cannot afford not to borrow.
This
argument does not hold for a government without its own central bank,
in which case it faces exactly the same budget constraint as the
oft-cited Swabian housewife. That is why some eurozone member states got
into so much trouble until the European Central Bank rescued them.
The national debt is deferred taxation. According
to this oft-repeated fallacy, governments can raise money by issuing
bonds, but, because bonds are loans, they will eventually have to be
repaid, which can be done only by raising taxes. And, because taxpayers
expect this, they will save now to pay their future tax bills. The more
the government borrows to pay for its spending today, the more the
public saves to pay future taxes, canceling out any stimulatory effect
of the extra borrowing.
The
problem with this argument is that governments are rarely faced with
having to “pay off” their debts. They might choose to do so, but mostly
they just roll them over by issuing new bonds. The longer the bonds’
maturities, the less frequently governments have to come to the market
for new loans.
More
important, when there are idle resources (for example, when
unemployment is much higher than normal), the spending that results from
the government’s borrowing brings these resources into use. The
increased government revenue that this generates (plus the decreased
spending on the unemployed) pays for the extra borrowing without having
to raise taxes.
The national debt is a burden on future generations. This
fallacy is repeated so often that it has entered the collective
unconscious. The argument is that if the current generation spends more
than it earns, the next generation will be forced to earn more than it
spends to pay for it. (this is the favourite mantra of the disappearing ACT party and, on occassions, Key (the money dealer) )
But
this ignores the fact that holders of the very same debt will be among
the supposedly burdened future generations. Suppose my children have to
pay off the debt to you that I incurred. They will be worse off. But you
will be better off. This may be bad for the distribution of wealth and
income, because it will enrich the creditor at the expense of the
debtor, but there will be no net burden on future generations.
The
principle is exactly the same when the holders of the national debt are
foreigners (as with Greece), though the political opposition to
repayment will be much greater.
Economics
is luxuriant with fallacies, because it is not a natural science like
physics or chemistry. Propositions in economics are rarely absolutely
true or false. What is true in some circumstances may be false in
others. Above all, the truth of many propositions depends on people’s
expectations.
Consider
the belief that the more the government borrows, the higher the future
tax burden will be. If people act on this belief by saving every extra
pound, dollar, or euro that the government puts in their pockets, the
extra government spending will have no effect on economic activity,
regardless of how many resources are idle. The government must then
raise taxes – and the fallacy becomes a self-fulfilling prophecy.
So
how are we to distinguish between true and false propositions in
economics? Perhaps the dividing line should be drawn between
propositions that hold only if people expect them to be true and those
that are true irrespective of beliefs. The statement, “If we all saved
more in a slump, we would all be better off,” is absolutely false. We
would all be worse off. But the statement, “The more the government
borrows, the more it has to pay for its borrowing,” is sometimes true
and sometimes false.
Or
perhaps the dividing line should be between propositions that depend on
reasonable behavioral assumptions and those that depend on ludicrous
ones. If people saved every extra penny of borrowed money that the
government spent, the spending would have no stimulating effect. True.
But such people exist only in economists’ models.
© Project Syndicate
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